May 24, 2013
By Steve Blumenthal
PIMCO’s Blender
Being the investment geek that I am, there are several annual research meetings that I eagerly await to read about each year. One of which is PIMCO’s Annual Secular Forum. Picture a room full of some of the industry’s brightest thought leaders gathered to discuss and debate the current economic, fundamental and political environment. Fortunately, we all get access to the detailed review.
Mohamed El-Erian, the Co-Chief Investment Officer of PIMCO and global economic extraordinaire, wrote an article “New Normal… Morphing”. The outlook is a summary of PIMCO’s annual research meeting and highlights their current view and forward outlook.
Below are some highlights of the article and some of my thoughts (blue colored text) as it pertains to your investment needs:
- In Europe, with the lack of a comprehensive resolution, the collapse of the single currency will remain conceivable though not a dominant probability.
- SB: Unmanageable debt, unmanageable entitlements, super high unemployment and forced austerity remain a powerful force. Expect more central bank involvement and risk of spreading Cyprus-like bank tax (ok – theft). The European Bank balance sheets are a mess. Offsetting the deleveraging process will be continued currency creation. Storm clouds remain.
- The U.S. will continue to heal but maintain a cruising-growth speed that is not much greater than 2% on average.
- SB: Not a disaster but well shy of the 3.3% growth rate policy makers are counting on, which is unlikely to be achieved given the excessive level of U.S. and global debt and the dysfunctional political gridlock in Washington.
- Japan will have an initial growth surge but its sustainability will be challenged by challenging structural reforms and an increasingly less accommodating regional and global context.
- SB: The demographics in Japan pose significant risk. Japan is quickly becoming the next big story. Their currency creation game plan is nearly three times ours (relative to GDP). Watch for the currency imbalance this creates globally. Japan is winning the race to the bottom. I continue to favor short Yen as a targeted bet.
- China will maintain average growth in the 6%-7.5% range, underpinned by gradual economic rebalancing and continued efforts to manage risks in the financial system.
How about inflation?
- Here, we were quite evenly balanced with somewhat of a tilt toward the possibility of higher and less stable global inflation over the three to five year horizon. It remains a delicate balance, however, between two competing groups: (i) supply shock vulnerability, lower growth potential, currency debasement, etc. versus (ii) output gaps, limited price pass-throughs, deleveraging, fiscal contraction, etc.
- SB: Two risks here: bonds decline in value when interest rates rise and inflations diminishes purchasing power as income remains flat while costs of goods rise. My two cents is that inflation is a 2014-2015 issue, not today. As for rising interest rates, the Fed is currently in control with a zero interest rate policy and bond purchases of $85 billion per month, but risk rises as time moves forward. Inevitably, the Fed will need to change course. A Fed exit and unprecedented global central bank policy means higher rates in the future. Just not yet.
El-Erian’s conclusions on investment implications:
- Do not lose sight of the extent to which asset prices have been disconnected from fundamentals and, thus, require major eventual validation by fundamentals.
- SB: Look more intensely for opportunities away from the central bank wave. There are opportunities, don’t go to a place of fear.
- Resist the short-term focus of those financial pundits who have abandoned fundamentals in favor of just obsessing with what is cheaper only in relative terms. As an illustration in fixed income space, consider the absolute level of yields on highly risky sub-investment-grade bonds and ask yourself whether they bear any relation to the risk being underwritten.
- Do not give up liquidity cheaply.
- SB: In my view, critically important.
- Be careful of longs in currencies of hyperactive central banks that do not enjoy reserve currency status. And remember, the lineup of central bank activism will evolve quite a bit over the next few years.
- SB: There remains growing currency war risk. Today, the U.S. remains the global reserve currency while the Yen does not.
- Protect against haircuts. You should expect future sovereign and corporate rescues to involve a growing set of bail-ins. Whether you call them haircuts or the more politically correct “PSI” (private sector involvement), a larger part of the capital structure is now vulnerable to capital losses. Click here for a link to Gross’ article.
- Evolve risk management approaches. Correlations have and will continue to change in this fluid world heavily impacted by central banks. Diversification, while necessary, is no longer sufficient for portfolio risk mitigation. Tail hedging can be an important addition, which also speaks to a broader issue: Narrow product mindsets need to continue to evolve into more holistic solution approaches. (Emphasis in bold is mine)
- Finally, recognize that consensus return expectations may adjust down from here. The whole point of all this unusual central bank activism is to bring to today future growth and future returns – hopefully to put economies and markets on a better long-term trajectory but also exposing them to the risk of severe air pockets should growth disappoint.
I am always amazed at the depth of important information we all have instantly available to us via the internet. I find myself often reflecting on the intelligence we hold in the palm of our hands. It’s exciting and pretty darn cool.
I believe you’ll find this research, poured generously from PIMCO’s Blender, an important read.
Here is the link to “New Normal… Morphing”.
Have a great Memorial Day weekend! Wishing you and your family the very best.
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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